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Ponzi Game Needs Equitable Solution

Social Security: Only more work and greater saving offer fiscal health to those retiring in next 25 years.

April 11, 1999|VICTOR R. FUCHS and JOHN B. SHOVEN | Victor R. Fuchs is an economics professor emeritus and John B. Shoven is an economics professor at Stanford University

In 1967, Paul Samuelson declared in his Newsweek column that Social Security was the greatest Ponzi game ever contrived. At the time, it looked as if rapid population and productivity growth would continue indefinitely, allowing succeeding generations to collect far more from Social Security than they themselves contributed to it. But times have changed. Now, everyone from President Clinton to the Social Security actuaries has concluded that the system faces serious long-term solvency problems. Productivity growth hasn't matched the pace of the 1950s and 1960s. Moreover, birth rates have been low since 1973, life expectancy has been rising rapidly, and the average age of retirement has been falling. Thus, the number of retirees per worker is projected to rise by more than 50%. The system requires major reform and repair.

No one should imagine that minor changes will do the job. The forecasted future receipts of Social Security are several trillion dollars short of what would be needed to fund currently legislated benefits. The Office of the Actuary of Social Security has calculated that it would take an immediate 38% increase in the Social Security payroll tax rate to fund currently legislated retirement and disability benefits. A smaller tax increase would just postpone the date of insolvency, leaving even higher tax rates for future generations. There is no painless way out of our situation. Our choices as a country are similar to those faced by any family that is not saving enough for retirement. The family either can cut consumption and save more, or live on less in retirement.

For Social Security, this means either finding new sources of revenues or cutting retirement benefits. To delay action because the difficult times are 12 to 15 years in the future will only intensify the problem.

Every legitimate plan to save Social Security must reduce benefits and/or increase revenues, but not all interventions are created equal, even if they have equal effects on the Social Security balance sheet. Some will improve incentives to work and save; others will have the reverse effect. Some will be regarded as fair by most Americans, while others will be seen as unfair. Some are primarily bookkeeping tricks that do nothing for the economy or for succeeding generations.

For example, raising the age of eligibility for full retirement benefits (sooner rather than later) would increase the Gross Domestic Product because many workers would stay in the labor force longer. Many observers believe that it also would be fair to raise the retirement age because the life expectancy of older Americans has been increasing at a brisk pace. In 1995, the average 65-year-old man could expect to live a full two years longer than his 1975 counterpart. Thus, he would collect two additional years of retirement benefits without having worked any longer than the man born 20 years before him.

Adjusting the retirement age to take account of greater life expectancy would be fair, good for Social Security and the economy. By contrast, the numerous proposals to save Social Security (and Medicare) by imposing extra taxes on the elderly or by means testing benefits penalizes those who saved for retirement.

When evaluating the fairness of policies that increase redistribution of income among the elderly, two facts should be considered:

* There is already less income inequality after age 65 than at any other age. If the country wishes to move toward greater equality, families with small children deserve high priority; the elderly are probably the last place to start.

* A significant portion of income inequality among the elderly arises from inequality in accumulated savings (including private pensions). Research at the National Bureau of Economic Research shows that this is not primarily the result of inequality in lifetime earnings; it results from differences in spending and savings decisions made throughout adult life.

Probably the most deceptive policy proposal is to "save" Social Security by switching investments from bonds to stocks. This so-called painless approach has won adherents on the political left and right; they focus their rhetoric on whether the switch should be made by individuals in private accounts or by the government in a collective account.

But swapping bonds for stocks is suspect. Stocks are riskier than bonds--that's why their average yield is higher. And swapping bonds for stocks does virtually nothing to increase economic output. It should be obvious that if the government sells bonds and buys stocks, the public will own fewer stocks and more bonds. The country as a whole is no better off than before the swap.

There is no magic bullet that will painlessly assure income security for those who retire in the first quarter of the next century. That only can come from more work and greater saving. Policies to reform Social Security should be chosen with those goals in mind.

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